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Costly Rewards and Punishments

Author

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  • Lee Frances Z. Xu

    (Quinlan School of Business, Loyola University of Chicago, 16 E Pearson St, Chicago, IL 60611, USA)

Abstract

To punish an agent, the principal often incurs costs. I study a principal’s least costly reward and punishment scheme for an agent whose effort the principal cannot observe. I find the principal’s cost is sometimes minimized by using both costly rewards and costly punishments because (1) the agent has an outside option, or (2) a principal without commitment ability repeatedly interacts with the agent. I also find that when an agent’s effort is better at increasing the probability of a good outcome for the principal, the agent’s payoff may decrease, because the principal replaces rewards with punishments.

Suggested Citation

  • Lee Frances Z. Xu, 2020. "Costly Rewards and Punishments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 20(1), pages 1-17, January.
    • Handle: RePEc:bpj:bejtec:v:20:y:2020:i:1:p:17:n:3
    DOI: 10.1515/bejte-2018-0131
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    More about this item

    Keywords

    costly punishment; principal-agent; moral hazard; outside option; credibility;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • L20 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - General
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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